Fed's Surprise Move Sends Markets a Mixed Message

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The Federal Reserve’s decision to finally enter the long-end of the Treasury market was taken as a mostly positive sign by the markets but it is probably making something of a bad statement on the health of the economy.

On the face of the things, the move to buy up to $300 billion in longer-term Treasurys over the next six months—which will encourage lending by lowering interest rates—turns Fed talk into action. It has been jawboning the market about making such a move for about six months.

The FOMC’s announcement Wednesday sparked an immediate rally in Treasurys, pushing down yields across the board, as investors flocked to the safe trade.

“You want to continue to buy what the government will buy,” Pimco’s Bill Gross told CNBC.

The Fed’s move is also meant to push down mortgage rates and borrowing terms in general, essentially doing an end run on banks and other lenders that are reluctant to extend credit as they deleverage amid a deep recession. Key to that strategy is lowering mortgage rates to help restart the moribund housing sector.

By Pandl’s estimate, the $300 billion will make a significant impact in the $1.8 trillion in long-term Treasury debt he expects to be issued this year.

What’s more, the FOMC also decided to up add to other key efforts, which have been well-received by the markets.

The committee said it will buy up to an additional $750 billion of agency mortgage-backed securities, bringing the total this year to $1.25 trillion. It will also double its purchases of agency up to $200 billion.

Though some might worry that the Fed’s latest moves to supply liquidity may provide more concern for an inflationary spike coming out of the recession, the central bank’s statement appeared to anticipate that.

“In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued," the Fed said. "Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer.”

Economists say the Fed’s latest steps have a negative dimension: The more dramatic the move, the more it says about the depths of the economic problems.

“It does suggest their outlook is a little bit more negative than Bernanke comments Sunday. There are no “green shoots here,” said Pandl, referring to the Fed Chairman’s interview on “60 Minutes”, when he suggested there were some cause for optimism about a recovery. “The description of the economy is quite clear. The FOMC did not point to any improving data."